Pay off Newer Income Taxes at Your Own Pace through “Adjustment of Debts”

Chapter 13 vs. Chapter 7 with Income Taxes

Chapter 13 is a court-approved payment program which usually takes three to five years to successfully complete. While you might think that being in a payment program doesn’t sound nearly as good as simply discharging (legally writing off) your debts in a Chapter 7 case, the fact is that some debts can’t be discharged under Chapter 7. Often federal income taxes cannot be. Our recent blog post titled Write Off Older Income Taxes Through “Straight Bankruptcy” lays out the four main conditions you must met to discharge an income tax debt through Chapter 7. If all or most of your income tax debts can be discharged under Chapter 7 by meeting those four conditions, you will not need the extra benefits of Chapter 13.

How Chapter 13 Deals with Income Taxes

But if you owe a lot of taxes that can’t be discharged, or owe both taxes that can be discharged but also much that can’t, Chapter 13 does the following for you:

If you do have any taxes that would have been discharged under Chapter 7 (generally, older income taxes), these are grouped together with all your ordinary “general unsecured” debts—such as medical bills and credit cards. These types of debts are paid only as much as you have available “disposable income” to do so, only after other higher priority debts are paid. This means that often this category of taxes is paid only a small portion of what you owe, or sometimes even paid nothing.

And if you ARE paying some of your “general unsecured” debts, you quite often are only obligated to pay a certain set dollar amount to this group as a whole. That amount is based on what you can afford to pay during the time you are in your Chapter 13 case, beyond what goes to the higher priority creditors. This means that if you owe older federal income taxes that are in this category, these taxes often do not add a penny to the amount you must pay in your Chapter 13 case. The taxes just reduce the amount the other “general unsecured” creditors receive, without costing you any more than if you didn’t owe those taxes.

Those taxes which would NOT have been discharged under Chapter 7 are also not discharged under Chapter 13. They are called “priority” debts, which must be paid in full during the course of your Chapter 13 case. But this comes with the following advantages:

The terms of payment to the Internal Revenue Service under Chapter 13 are based on your actual ability to pay instead of the IRS’s usual aggressive collection standards.

Penalties that were added to the tax before you filed Chapter 13—which can be a significant part of the tax debt—are not considered “priority” debts. Rather they are considered “general unsecured” debts, and so are not paid in full but rather as described above.

Usually interest or penalties stop accruing as soon as your Chapter 13 case is filed. As a result your balance is not constantly increasing, enabling you to pay off the tax faster.

During your entire Chapter 13 case you are protected from the collection efforts of the Internal Revenue Service. So you don’t have to worry about garnishments of your paycheck or bank accounts, tax liens, or any of the other aggressive methods it would usually use against you to collect the tax.

Because you are protected from the IRS, and because usually interest and penalties are not accruing, you have the flexibility to pay other even more pressing creditors in your Chapter 13 plan ahead of or alongside the IRS, such as child support back payments, or a vehicle loan arrearage.

Also, since “priority” taxes are paid in a Chapter 13 case before and instead of “general unsecured” debts, this often means that your “priority” taxes simply reduce the amount of money which would otherwise have gone to the “general unsecured” creditors. Under these circumstances, remarkably your tax debt would not increase the amount that you would have had to pay in a Chapter 13 case. Talk to your attorney to find out if this aspect would apply to you.

Conclusion

If you owe a large amount of federal “priority tax,” Chapter 13 will usually make dealing with your taxes much more manageable. Although a Chapter 7 case can write off some income taxes, if you owe more recent income tax, or multiple years of taxes, Chapter 13 is often the best option.

minefield. I’m Carrie Weir, a highly experienced Texas bankruptcy lawyer. I serve the areas around Rockwall, Heath, Greenville, Lavon, Wylie, Mesquite, Royse City, Sachse, and Rowlett. Please contact me for a free and confidential consultation. Please either just call me at 972-772-3083 or use the contact form here. Thank you.